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October's "Rule Breakers" Mailbag: 4 Questions on Bitcoin

Why is cryptocurrency different from all other currencies, and what’s going to change the market around it next?

On this week's Rule Breakers podcast, Motley Fool co-founder David Gardner brings in a special guest -- Aaron Bush from the Motley Fool Rule Breakers team-- to help him field some follow-up questions to their Oct. 18 tour-de-force episode on cryptocurrencies. The topics include how international government regulations will impact the currencies, which broker is the best to use, why blockchain has bigger potential than the cryptocurrency application, and what the long-term risk to bitcoin is once all the coins have been mined.

A full transcript follows the video.

This video was recorded on Oct. 25, 2017.

David Gardner: Mailbag Item No. 4: Rule Breaker Mailbag point No. 4. Well, actually, points No. 4 through No. 7. I have a special guest. If you were listening last week, you already know Aaron Bush from my Motley Fool Rule Breakers team. He's just released a report on cryptocurrencies, in fact, which you can talk about in a sec [maybe after], but we got a bunch of questions for you, Aaron, and you and I hand selected our four favorites and you're going to take them, because you'll take all comers.

Aaron Bush: Let's do it.

Gardner: You would have taken more than four...

Bush: Absolutely.

Gardner: ... but we have to control the time somehow on this podcast, so Aaron let's start with this one and it comes from Andrew Palmer. Andrew wrote, "With China's recent 'Bitcoin ban' and U.S. financial firms' increasing interest in Bitcoin and Blockchain, how do you see new Bitcoin-related legislation or lack thereof affecting the growth of this ecosystem?" Aaron?

Bush: That's a good question. I think, in general, regulation and legislation do have a tendency to slow down the growth of ecosystems; however, in this case I believe that having some rules is important to just simply cut back the scams and the bad actors, so I'm not completely against regulation, here.

I think that most countries are still wary of instituting too many regulations because they don't want to scare away entrepreneurs and let the value that they create go to other places, and so I think that's something that a lot of countries are thinking about in their regulation.

This is one of those things, too, where the currency lives on the internet, so you can't just have one worldwide rule.

Gardner: Jurisdiction...

Bush: Right. There is no jurisdiction.

Gardner: Yeah.

Bush: And so you start to see these companies create rules nation by nation. I mean, inside the U.S. I've actually been fairly impressed by the way the government is handling things, here. If you read through any of the reports the government has published, you'll see that the decision-making groups have a deep understanding of the technology.

Gardner: I am delighted to hear that.

Bush: Yes, it's fantastic. And the current approach that they're taking to regulating the industry is sort of like this. If it looks like a security, and it acts like a security, then treat it like a security. If it doesn't act like a security or look like a security, then don't treat it like a security. And I think that that's a very level-headed approach to managing legislation, here, and that should lead to a growing ecosystem of players, here, domestically.

However, like Andrew mentioned in his question, you do see countries like China ban ICOs...

Gardner: That's initial coin offerings.

Bush: Yes. Initial coin offerings, and they've started banning exchanges, too. So this really is a power play that's intended to suffocate the market. Now I'll say on one hand that actually makes me a bit bullish because that comes to show that...

Gardner: This is for real.

Bush: This is for real.

Gardner: China's trying to stop it.

Bush: Absolutely, but censorship does limit the growth of new ideas. But what's interesting to me with China is that they actually have proven pretty savvy in the past when it comes to managing cryptocurrencies, so I wonder if they're playing chess in some way, in a sense of maybe they're going to come out with their own cryptocurrency ecosystem.

So I think it's early. It's tough to tell. And I think over time we'll see governments learn how to better regulate this. Because this is a worldwide [phenomenon], I do believe that there always will be places where entrepreneurs are welcome, and I think that there will continue to be ways for tokenized ideas to grow increasingly popular.

Gardner: You know, this is a total digression and I'll keep it really short, but I had the pleasure of getting to see [not meet], but see the Prime Minister of Singapore earlier this week. I'm a member of something called The Economic Club of Washington, D.C., and people come through Washington from all parts of the world.

And, boy, was I once again so impressed by Singapore. When you say there will always be places for entrepreneurs, when you're a nation of five million people with no natural resources, starting from a really tough place 50 years ago, and you've gotten to be the size of economy that Singapore represents, that's a great example.

In fact, here's one thing I learned about Singapore, Aaron. They let in gambling, gaming. They didn't probably want to do it at first, but what the government decided is we will allow [it], because it's part of an ecosystem of tourism. Tourists come. They stay in the hotels. They want to do slots, that kind of thing. So they decided to let it in.

But here's the rule. Singapore natives, citizens, pay a $100 Singapore tax in order to go to the casino. So, you might ask who goes to the casinos, and the answer is all the people who are not citizens of the nation, itself. It's all the tourists who basically lose their money and pay Singapore. And Singaporeans can also gamble if they want, but they're going to be paying $100 tax to do so. Kind of interesting.

Mailbag Item No. 5: Anyway, question No. 2 for you. This is point No. 5 of this Mailbag and it comes [this is a quick one] from Del Clark. Del simply writes, "Which broker is best for cryptocurrency? Coinbase?"

Bush: I think that that is a good logistical question, because in the cryptocurrency world, the concept of brokerages doesn't really exist the same way that it does with stocks and equities. Instead you hold value in wallets, which are either software wallets or hardware wallets, and you trade on exchanges.

Now Coinbase is a respected and popular platform for buying and storing the most prominent cryptocurrencies. I think they support Bitcoin, Ethereum, and maybe Litecoin.

Gardner: Now Aaron, I'm not sure I've asked you this, but do you own any Bitcoin?

Bush: I do.

Gardner: OK, good. And did you use Coinbase?

Bush: I have in the past, yes.

Gardner: Excellent. Keep going.

Bush: So I think Coinbase is a great, simple solution. However, there is a trade-off. With Coinbase, you don't actually hold your own private key, which is ultimately what makes whatever you own yours, so you have to have trust in the company just like you would a normal bank.

Gardner: It's kind of like a broker. They used to hold the paper securities in the vault, and that's one reason you would use a broker, is that they would have the actual shares that you had safe. Safe and sound. So that's very real, here, for cryptocurrencies.

Bush: Right. So much of this movement is toward decentralization and this is sort of a centralized player. Some people like that. Some people don't. I think it's ultimately up to you to decide if you like that.

However, that's only for those very few specific leading cryptocurrencies. If you wanted to buy another cryptocurrency, you would need to create an account at an exchange, and a couple of examples are Kraken and ShapeShift. There are a bunch of different players, but those are two leaders right now. And through that exchange you exchange either your chosen fiat currency or cryptocurrency like Bitcoin for whatever else you want to buy and there are thousands of cryptocurrencies you can buy through these exchanges now. And it's just like a normal currency exchange, but crypto.

So you can generally hold value in those exchange accounts, but it's typically safer to move those accounts, then, to a wallet and as I mentioned there are software wallets, which are simply downloadable and you can store them there. They're secured cryptographically. Or a hardware wallet, which is like a separate container that you plug in via USB to the computer and you can transfer your digital assets over there and unplug it. So it can't be hacked, because it's not connected to the internet.

And so the last thing I'll say is that standardization is growing between these cryptocurrencies, but many cryptocurrencies still have different requirements, so it still is very much a case-by-case example. It's not super user-friendly yet, but it's slowly getting there.

Gardner: Awesome. Thank you, Aaron, and thanks Del Clark for a good question.

Mailbag Item No. 6: And here comes another one. This is from Tobin Anthony. This is Rule Breaker Mailbag No. 6. A friend of The Fool, Tobin Anthony.

"David, I heard Marc Andreessen say a while back on EconTalk," [thanks, Tobin says, by the way, for mentioning that podcast on an early Rule Breaker Investing episode], "saying that Blockchain was going to be the basis of contractual dealings in the future. He thought it was more important than cryptocurrency. Aaron made similar comments on last week's RBIPodcast. Can you get Aaron to explain what is it about the nature of Blockchain that allows for secure document exchange? Thanks."

Now that shouldn't be too hard, Aaron, right? You can just explain all the technical underpinnings. This is right within your wheelhouse. Anyone could do this.

Bush: Well, I'll try to keep it...

Gardner: Tobin should have just googled this himself and figured it out.

Bush: Yeah, come on Tobin. No, I'm happy to help and I'll keep this relatively big picture. So probably about 20 years ago, a man named Nick Szabo, who's become highly respected in this field, realized that the logic of legal contracts is very similar to the logic of programming. It's highly structured with set parameters and cause and effect are explicitly detailed in the contract or the code.

And what that means is that legal documents, where there's an exchange of some sort, can be programmed. And if the content of the deal resides on the internet [information and value]...

Gardner: Transparent. It's out there.

Bush: Right.

Gardner: Accessible.

Bush: If so then the entire thing can be set up and executed in code. And this is what has become known as smart contracts.

Gardner: And is that one word, Aaron, or two.

Bush: Maybe put a hyphen.

Gardner: We'll go hyphen. Smart hyphen. I need to know, so thank you.

Bush: I think it's two, but I like the hyphen personally. So Blockchains are what make these smart contracts secure for the first time. Because of its distributed nature, any exchange or transaction that takes place must be verified by the miners across the network, and all of the miners must be in sync with each other. If something is off, or if one node is overridden in the transaction, the network will know that something is wrong just through that inconsistency.

So in other words, decentralization creates transparency across the entire network, and leaves no room for any funny business. The code executes itself. The miners prove it and verify it. Corrupting a Blockchain means corrupting every single node in the network, and the probability of that is about as close to zero as you can get for these really large networks, and that is what makes it secure.

I'll just quickly say that of course some exchanges are bound to add complication. It will be a lot easier for me to say, "Hey, David. Let's make a bet. Let's each choose a stock, and a hundred days from now, whoever's stock went up the highest percentage, the other person will give them one Bitcoin." That will be a lot easier to set up than say, "Hey, David. I want to buy your house using a Blockchain." There's just many more inputs. It's more complicated. A lot of those factors might live naturally outside of the internet.

That said, over the past month the first real estate transaction was made using a Blockchain. So I expect more possibilities to open up, but it's really because of the Blockchain that makes it secure.

Gardner: So Aaron, do you want to take that bet, by the way? What's your stock? A hundred days from now? Is that what it was?

Bush: I don't know if I'm willing to bet that much on a stock.

Gardner: Since only one of us has a Bitcoin, I guess only one of us could really win something from the other guy, so I'm going to say Match Group. What have you got? Match Group. That's my pick.

Bush: I'll go with Momo.

Gardner: Good, Momo, which is ticker symbol [MOMO]. This is not an official bet, and we didn't actually do this on the podcast, but we could have. And if we did, we could make it a Blockchain-contracted exchange.

Bush: Boom!

Gardner: OK, which takes us to the final Blockchain question of this episode. "Hi, David." This is written by [Allen Morris]. "Hi, David. Because Bitcoin is finite, after 21 million coins mined there will be no more to find." This is not, by the way, a Dr. Seuss poem.

"What will happen to all those miners and all the assets they build up to mine for coins? If they were incentivized to process data and keep the system honest, how will they be incentivized when there are no more coins to be found? At that point, who will police the system? What would be in place to prevent Bitcoins from, say, becoming worthless?"

A little bit more to this question, Aaron. "My concern is," Allen writes, "that in five, 10, or X years, Bitcoin loses its governing body because of the lack of financial interest, and then what? Aaron was a wealth of information," he goes on to say. This is a little compliment...

Bush: Aw, shucks.

Gardner: ... for @AaronBush on Twitter? Is that who you are?

Bush: AaronBush100.

Gardner: AaronBush100. So a little compliment for you. "A wealth of information. I love your podcast. You've made an amazing impact in my life and my investment practices over time. I look forward to hearing how you and your team might respond. Thank you. Cheers. [Allen Morris]."

Bush: Awesome! Thank you, Allen! I'll say that part of what you mentioned there is true and part of it is a bit of a misperception or misconception. Let's remember, first of all, that we're talking specifically about Bitcoin, here, because some other cryptocurrencies have different monetary policy. They might increase their supply into perpetuity.

Gardner: OK.

Bush: But with Bitcoin what is true is that the miners do compete to win over the new tokens that are being released, and that will happen until... It's expected at 2140 [their 2140]...

Gardner: The year 2140. Circle that on your calendars, Fools.

Bush: So we can be a little bit patient, here. But what is not true is that the miners are provided Bitcoins from that unreleased pile when they work to verify transactions across the network. Instead they're paid transaction fees by those conducting the transactions. So for all intents and purposes, the incentive to maintain the integrity of the network shouldn't go away, even if the supply remains stagnant.

I will say, though, that Bitcoin hasn't proven to be the most scalable network for transactions in the sense that if you are to conduct the large transaction, the fees will be substantially high. I do expect that to change over time as the code, itself, that's running the Bitcoin network improves just to make it more energy efficient and such...

Gardner: OK.

Bush: But yes, transaction fees take care of that.

Gardner: Aaron, you mentioned earlier you own some Bitcoin. Have you mined?

Bush: I have not mined any Bitcoin.

Gardner: You kind of need to bring extra skills, right? I know that you have many skills. You've done some programming for me, for example, but that's almost a full-time call with some serious expertise for the miners. Am I right?

Bush: I have downloaded the Bitcoin software, but it's so competitive, now, that's when you've got to have...

Gardner: That supercomputer we talked last week.

Bush: You've got to have a supercomputer. I don't have a supercomputer sitting around, unfortunately.

Gardner: Understood. Well, we're awfully glad that instead of mining something off somewhere, instead you're here at The Motley Fool with Rule Breakers [on my team there] and the Rule Breaker Investing podcast. Now I know that there is a report that you worked hard on that is just being released. Could you briefly, before we move to Mailbag Item No. 8 and welcome our next guest to this week's variety show, put a brief plug in for that, Aaron.

Bush: So for all of our Premier Pass members, which is a service that provides all of our front-end and back-end services, we give some specific portfolio allocation guidance, as well. For all of those members we are unveiling a new Cryptocurrency and Blockchain report which is a four-part series detailing just so much that there is to know about this stuff.

Gardner: All the things! All of them.

Bush: Right. And we're opening up Premier Pass and all the new subscribers will be able to get this four-part report.

Gardner: Outstanding. Aaron, thank you very much for sharing some more of your expertise, and a delight to have you back.

Bush: Thank you, David.

Aaron Bush owns shares of Momo and Twitter. David Gardner owns shares of Match Group. The Motley Fool owns shares of and recommends Twitter. The Motley Fool recommends Match Group and Momo. The Motley Fool has a disclosure policy.